Carvana (NYSE: CVNA) has accomplished the unthinkable. The company sought to remake the fragmented used-car market by transacting and financing online. It then completes the transaction at a customer's home or by pick-up and delivery points, some of which are called "car vending machines." This reduces the high overhead costs of operating dealerships like its competitor CarMax.
After staring at the brink of bankruptcy, a debt restructuring deal rescued the stock. The company has now reported an earnings before interest, taxes, depreciation, and amortization (EBITDA) profit and positive net income for each of the first two quarters in 2024.
Thanks to that recovery, the retail stock is up more than 2,900% since the beginning of 2023. But does this recovery mean it's safe for investors to buy?
Carvana's second-quarter report
Improving car sales have played a critical role in Carvana's success. In Q2, its net sales and operating revenue of $3.4 billion grew 15% from year-ago levels. This fell short of the 33% increase in unit car sales, an industry now dealing with falling prices for used automobiles.
Also, the company limited the growth of operating expenses to under 1%. This resulted in a positive operating profit -- so positive that even after $173 million in interest expenses, Carvana eked out $18 million in net income. The company lost $58 million in the same quarter last year.
Additionally, Carvana has succeeded in keeping positive free cash flow, generating $415 million in the first half of 2024. This is a slight improvement over the same year-ago period when it generated $393 million, a factor that may have helped the stock recover last year.
Regarding its outlook for the rest of the year, the company was vague, merely setting an expectation for sequential growth in car sales and positive EBITDA. It expects EBITDA of $1 billion to $1.2 billion for 2024, up from $339 million last year. Still, since EBITDA doesn't include interest, taxes, depreciation, or amortization, it's unclear if that will mean a positive net income.
Lingering dangers
The optimism surrounding Carvana's recovery has made its stock relatively expensive. Even if the recent profit is used to measure the company's valuation by the price-to-earnings ratio (P/E), its price-to-sales ratio (P/S) of 2.2 is deceptively high when considering the average 1.4 P/S ratio over the last five years.
Furthermore, the state of the economy is uncertain. Should car sales fall back to last year's levels or lower, Carvana would likely return to net losses, a prospect that could derail its recovery.
Moreover, despite its restructuring, the company's debt load is an ongoing concern. The total debt fell from more than $6 billion at the end of 2023 to $5.5 billion at the end of Q2. Still, that's heavy for a company with only $115 million in stockholders' equity. Also, most of that debt has interest rates between 12% and 14%.
Fortunately for Carvana, none of its long-term debt comes due before 2028. Nonetheless, the company generated $415 million in free cash flow in the first six months of 2024, so it will have to maintain that pace to significantly reduce its debt and hopefully refinance the rest of it at lower rates.
Continue to avoid Carvana stock
Amid such conditions, Carvana remains a high-risk stock that most investors should avoid. Admittedly, the company has shown surprising resiliency in bouncing back from the brink of bankruptcy and becoming operationally profitable, and the falling total debt is an encouraging sign.
However, the turnaround story could still be derailed if sales fall. Additionally, its P/S ratio is nearly double its long-term average, indicating that the stock price is far ahead of fundamentals. Unless that metric falls below the average, investors should stay away from this stock.
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Will Healy has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends CarMax. The Motley Fool has a disclosure policy.
